20 questions. How do mortgages work?

March 1, 2020
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How do mortgages work?

A mortgage is a loan used to buy a house or property. You will pay back the loan over a significant period of time, in addition to interest on the loan. You will typically need to provide a deposit, which will be a percentage of the total value of the house. Most lenders will request between 5-25% deposit, depending on your circumstances.

Once you have secured a mortgage, you will be able to move into the house. However, you will not own the house until the mortgage has been paid off in full. You will make monthly payments to pay off your mortgage, usually over multiple years. The typical mortgage term is 25 years. Some lenders will allow you to borrow over a shorter period of time if you expect to be able to pay it off sooner. And some lenders will allow you to take longer to reduce your monthly payments. If you take a mortgage over a longer period, your total interest payments will be much higher.

In addition to paying off your mortgage, you will also pay interest on the amount borrowed. When choosing a mortgage, you will have to choose between a fixed rate or variable interest rate mortgage. If you choose a fixed rate mortgage, your mortgage payments will be the same for the duration of the agreement. If you choose a variable rate mortgage, your payments will be linked to the Bank of England base rate, or will be controlled by your lender. This means your mortgage repayments could increase or decrease every month or every year.

In the early years of paying back your mortgage, a larger portion goes towards paying off the interest and a small portion goes towards paying off the capital. As your debt decreases, you will start to pay off more of the capital every month. While you are able to live in the house and even sell it for the duration of the mortgage, you will not own it completely until your mortgage payments are complete.

Some mortgages will allow you to “port” them to another property, which means you could move to a house of the same or lesser value without changing your mortgage payments. If you move to a more expensive home, you could be asked to pay a higher interest rate on the top up amount. For mortgage preparation please see our infographic guide.

20 questions. How do mortgages work?

How do buy to let mortgages work?

A buy to let mortgage is a special type of mortgage for landlords who want to buy a property solely with the aim of renting it out. While there are some similarities between a residential mortgage and a buy to let mortgage, there are some key differences.

The biggest difference that borrowers will notice is that a buy to let mortgage will require a larger deposit. While you might be able to secure a residential mortgage with a deposit as low as 5%, with a buy-to-let mortgage, the deposit will need to be much larger. The interest rates and fees for a buy to let mortgage will also be much higher, so you will need to factor this into your calculations. And finally, you will not be permitted to live in your own buy to let property. There are also strict rules about letting your property to close family members.

The minimum deposit for a buy to let mortgage is usually around 25%. But it can be as high as 20-40% depending on the lender. Most buy to let mortgages are interest-only, which means you only make interest payments for the lifetime of the mortgage. At the end, you will be expected to pay the mortgage in full.

Instead of looking at your income to determine how much you can afford to borrow, lenders will look at how much rental income you can expect to receive. You will typically need the rental income to be around 25-30% above your mortgage payments. This will allow you to factor in things like letting agent fees and repairs or upgrades to the property.

Many of the big banks offer buy to let mortgages, or you can work with a specialist lender to find the best deal.

How do lifetime mortgages work?

A lifetime mortgage is a loan which is secured against your home which does not need to be repaid until you pass away or move into long-term residential care. This can allow you to free up the wealth from your home without having to move house or downsize.

A lifetime mortgage allows you to borrow money against your home. You can also protect a portion of the value of your home as an inheritance for your family. You get to stay in your home without paying rent and will still be responsible for maintenance.

You will pay interest on the amount borrowed, but this can be added to the total loan amount. When you pass away or move into residential care, your home is sold and the amount received from the sale of your property is used to pay back the loan and any outstanding interest.

Anything that is left over after paying back your loan and interest will be passed to your beneficiaries. And if your estate is able to pay back the loan without selling the property, this is also available as an option.

In some cases, there might not be enough money to pay back the loan and so your beneficiaries would have to repay anything above the loan value from your estate. To protect against this, many lifetime mortgages offer a no-negative equity guarantee. This will ensure your beneficiaries don’t have to pay back more than your home is worth.

How do offset mortgages work?

An offset mortgage is linked to your savings account. It allows you to balance your savings against the amount you have left to pay on your mortgage. It can allow you to reduce the amount of interest you pay.

With an offset account, you won’t earn interest on your savings. But you will save money on your mortgage interest. Since most people will pay more on their mortgage interest than they earn in interest on their savings, this type of mortgage can save you money.

You can still take money out of your savings account, but if you do so, it will no longer be offset against your mortgage. This means that the amount of interest you owe will go up and your monthly mortgage payments will increase. You will need to keep a minimum amount in your savings account. It’s important to check the minimum amount before choosing your offset mortgage deal.

An offset mortgage will also allow you to make overpayments and pay off your mortgage faster. To make overpayments on an offset mortgage, you would have to agree to still pay the interest, even though it is offset. This would mean you would pay back your loan faster without having to part with your savings; your savings would still be available when you need it.

An alternative to an offset mortgage would be to put down a larger deposit to help lower your fees and interest rates. However, using an offset mortgage can give you greater financial freedom as you will always have access to your savings. Without this option, the only way to access that money again would be to sell your home.

How do interest only mortgages work?

An interest-only mortgage is a type of mortgage where you only pay off the interest and not the capital loan amount. At the end of the loan term, you will have to pay back the loan amount in full. When you are only paying the interest, your monthly payments will be much lower. It’s important that you have a plan in place for saving or investing so that you can pay back the loan in full at the end.

An interest only mortgage will typically be more expensive than a repayment mortgage. This is because as you chip away at your mortgage debt, the monthly interest payments will decrease. But if you do not reduce the size of the original loan for the entire life of the mortgage, the interest payments will remain high.

Interest only mortgages are difficult to find as many lenders stopped offering them after the 2008 financial crash. The requirements for securing an interest only mortgage are much stricter today. Lenders will often expect to see a much larger deposit, usually around 50% of the value of the property. They may also ask to see evidence of an investment vehicle that will allow you to pay back the loan in full.

Your income may also be put under greater scrutiny for an interest only mortgage and some lenders will only consider applications from high income individuals earning in excess of £100,000 per year. See Which? podcast that is useful.

20 questions. How do mortgages work?

How do repayment mortgages work?

A repayment mortgage is the most popular type of mortgage. There are two main types of mortgages, interest-only and repayment. With a repayment mortgage, you will pay back the capital on the loan in addition to interest payments. With an interest-only mortgage, you will only pay back the interest and then pay the full value of the loan at the end of the repayment period.

As you are paying back the capital amount in addition to the interest, this type of mortgage will be more expensive in the short-term. Your monthly mortgage payments will be higher than if you were to have an interest-only repayment plan. However, in the long-term, a repayment mortgage will work out cheaper.

At the start of the mortgage repayment period, you will be paying more interest and less towards the capital. As time goes on, the amount of debt is reduced and you will start to make bigger monthly payments towards the capital loan.

With a £200,000 mortgage, you would pay £1,002 per month assuming you have a 25 year repayment plan and an interest rate of 3.5%. This would mean you would pay £100,477 in interest, with a total repayment of £300,477. For an interest-only mortgage, you would pay £584 per month but a total of £375,161, of which £175,161 would be interest payments. Follow here for some more in-depth information,

How do joint mortgages work?

A joint mortgage is where you apply for a mortgage with another person, usually a partner, friend or relative. You will both be liable for the mortgage payments and you will have an equal claim to the property. When submitting a joint mortgage application, both parties will need to meet the lending criteria. This can increase the amount of money you are able to borrow as both incomes will be considered.

In the event that one person is unable to pay their share of the mortgage payments, the other person will have to pay the full amount. When taking out a joint mortgage, it is important to choose the correct legal entity. You will have to choose between being joint tenants or tenants in common.

A joint tenants agreement would be most appropriate for spouses or those in a long-term relationship. You would have equal rights to the property, you would be able to claim an equal share of the profit from the sale, and the other party would automatically inherit the property if the other person passed away.

With a “tenants in common” agreement, each person would have an agreed share of the property. This makes it ideal for friends sharing a property, or for relatives purchasing a property together. Rather than the other party or parties inheriting the property in the event one of the people named on the mortgage passes away, each person can decide who will inherit their share in their will. For Joint mortgages for the self-employed see our past post.

How do interest only mortgages work uk?

In the UK, interest only mortgages are becoming less popular. There are still many people on an interest only mortgage, but the pressure to pay the full capital amount on an interest only mortgage can prove to be too much for some people.

With a repayment mortgage, the monthly mortgage payments contribute to reducing the capital loan amount while also paying the interest payments. At the start of the loan, a greater portion of the repayment will go towards paying the interest. With an interest only mortgage, the borrower only pays back the interest every month. At the end of their mortgage period, they will be expected to pay back the value of the property in full.

With lower monthly payments, it is expected that the borrower will put money towards a repayment vehicle to ensure they have the money to pay back the loan in full at the end of the repayment period.

Savings might be effective, but not everyone will be able to put away enough money to repay their mortgage in full at the end of the term. Investments can also be problematic as there are no guarantees. It also requires the borrower to ensure they are investing enough money to cover the mortgage amount. At the end of the mortgage, if you are unable to pay back the full value of the loan, you may need to remortgage or sell your property.

How do commercial mortgages work?

If you are a business owner looking to manage the costs of renting premises, a commercial mortgage could help. Similar to a residential mortgage, a commercial mortgage involves borrowing money from a lender in order to purchase property or land. Although the commercial mortgage market might be smaller than the residential mortgage market, the value is significantly higher. Commercial mortgages might include:

  • Purchasing business premises
  • Securing land for development
  • Purchasing owner-occupied premises
  • Starting and expanding a buy-to-let portfolio

A commercial mortgage is used for more than just securing a property. Many business owners will view a commercial mortgage as another source of business funding. It can help businesses to free up capital and even protect their business against future rent rises.

A commercial mortgage application will look at the borrower’s credit history in addition to the business accounts. Commercial mortgages will also require a much larger deposit up front, usually around 40% of the property value.

For start-up companies which are asset rich but cash poor, lenders may accept other assets as a form of security. This could mean using a residential property as security against a commercial mortgage.

As with any kind of lending, it is important to shop around and consider the full implications of any borrowing decision. Commercial mortgage terms typically last between 5 and 40 years, so it is a significant undertaking.

20 questions. How do mortgages work?

How do guarantor mortgages work?

A guarantor mortgage can help those who might be unable to secure a mortgage on their own to get on the property ladder. If a person has a poor credit rating or they don’t meet the lending criteria, then a guarantor mortgage can help.

With a guarantor mortgage, a person will co-sign on a mortgage with the understanding that they will have to make the payments if the borrower is unable to do so. This can give lenders some reassurance that the mortgage will still be paid, even if the borrower runs into short-term problems.

The guarantor will agree to continue with the agreement until the loan to value (LTV) has reached a certain amount. After this point, the borrower will be solely responsible for meeting the mortgage payments. The guarantor does not have any legal claim to the home, so it is important to understand the agreement that is taking place.

If the guarantor would like to control a share of the property then a “tenants in common” joint mortgage would be more appropriate. This would allow the guarantor and the borrower to agree to a percentage split of the property. Other ways to help a person purchase a house include a family offset mortgage. This would allow a parent or guardian to use their savings to offset the interest on a mortgage and lower the monthly payments for the borrower.

How do banks work out mortgages?

There are a number of different factors that banks use to determine how much a person can borrow and how much they will have to pay back. In the past, the amount you could borrow was a simple calculation based on your income. It would typically be around 5 times your annual income. Today, mortgage providers will typically not lend more than 4.5 times your annual income. This calculator from money saving expert is useful.

Lenders will also look at other factors that could impact your ability to pay back your mortgage every month. When applying for a mortgage, lenders will take a close look at your finances to determine if they will grant you a mortgage. They will start with your income and outgoings to determine if you would be able to meet the mortgage payments.

They will also question if you would be able to continue to meet your mortgage payments if rates were to rise or if your circumstances were to change. For example, if you are nearing retirement, they may ask to see proof of your retirement income to make sure that you will still be able to meet your obligations. They may also question what would happen to your finances if you were to be made redundant, have a child, or take a career break.

When it comes to calculating your rates and fees, these will largely depend on your deposit and your credit rating. By providing a large deposit, you will be applying for a smaller loan in proportion to the value of the property. This means that your interest payments would be lower over the lifetime of the loan.

How do adjustable rate mortgages work?

When applying for a mortgage, you will need to choose between an adjustable rate mortgage and a fixed rate mortgage. An adjustable rate mortgage is fixed to the Bank of England interest rates. This means that your mortgage repayments will vary throughout the lifetime of the mortgage.

With an adjustable rate mortgage, you may find that you pay less than you originally planned if the Bank of England base rate falls during the lifetime of your mortgage. But it could also be more expensive if the interest rate increases. It’s important to factor in potential changes to the interest rates when submitting your application.

At the start of the loan, the interest rate will often be fixed for a specific period of time. After this time has passed, the interest rate on the remaining loan will reset periodically. This interest rate will usually reset once a year, or it could reset monthly, meaning that your mortgage payments could change every month.

Adjustable rate mortgage caps may be in place to ensure that your interest rates don’t go above a certain amount. This can help to offer some protection, but it is still important to consider the financial implications of a significant change in your monthly mortgage payments. See some further pros and cons from The Balance.

How do variable rate mortgages work?

When choosing your mortgage product, the biggest decision you will have to make is between a fixed rate and a variable rate mortgage. A fixed rate mortgage will allow you to fix your mortgage payments so that you know you will always pay the same amount. A variable rate mortgage will change depending on the Bank of England’s base rate.

While this can mean that your mortgage payments could increase, there is also the chance they could go down. This can be a tempting prospect for many prospective home owners as it means that they won’t have to pay more than they need to in interest payments.

There are two main types of variable rate mortgages, the standard variable rate and the tracker rate. A standard variable rate mortgage is determined by your lender. While it is often linked to the Bank of England base rate, lenders also have the option to tweak this amount without linking it to the base rate. A tracker rate mortgage follows the movements of the Bank of England base rate exactly.

A tracker rate mortgage will have an index and a margin. The Bank of England base rate will be the index while there will also be a fixed margin on top of this. This means that your interest payments may be 2% above the Bank of England base rate. It’s important to consider the impact a change in your interest rates and mortgage repayments could make to your monthly finances. You can see Money Facts for some more detailed information.

How do mortgages work when moving house?

If you are selling your current mortgaged property and buying another property, you may be wondering what will happen to your mortgage. When you sell a mortgage property and buy a new one, your lender will use the money from the sale of your current home to pay off the existing mortgage and begin a new mortgage agreement on the new property.

Many lenders will allow you to simply “port” the old mortgage to the new property, allowing you to keep the same mortgage agreement and monthly payments in place. Not all mortgages are portable, so you will need to check your loan documentation. If your loan isn’t portable, you will effectively have to apply for a new mortgage on the property. Early repayment penalties may apply, but this will depend on your mortgage terms. This will typically be a percentage of your outstanding debt.

When moving to a new home, you will have to think about the value of the new home. If your new home is more expensive, the rates on the additional debt may be different to that from your previous mortgage. And even if your mortgage is portable, you will still need to go through the same eligibility checks as you did with your first mortgage. If your circumstances have changed significantly, this could impact your ability to access mortgage products.

20 questions. How do mortgages work?

How do shared ownership mortgages work?

Shared ownership schemes are sometimes known as part ownership schemes. This is a government initiative that aims to help first-time buyers and those on lower incomes to get on the property ladder.

A shared ownership scheme works by giving buyers the opportunity to buy a portion of a property and then pay rent on the remaining amount. The remaining portion of the home may be owned by a housing authority or a property developer. Buyers can typically purchase between 25% to 75% of a property. This significantly reduces the deposit they will require and can allow individuals to move into a higher value property. See Money Advice Service.

Over time, they will have the option to purchase more of the property, or the whole property. To do this, you would need to have the property valued again. If the value of the property has increased, you could end up paying more than you did for your initial share.

The rules for shared ownership eligibility are very strict. You will have to have a household of under £80,000 to quality, and £90,000 in London.

If you are eligible, you will only have to provide a 5% deposit, but you can offer more if it is available. Remember that a rental fee will be due to the housing authority responsible for running the scheme, so this should be factored in to affordability calculations.

How do equity release mortgages work?

Equity release is advertised as a simple way to release value from your home without having to move house or downsize. An equity release mortgage is available to people over the age of 55. It is an agreement to release a portion of the value of your house as a lump sum. Money Saving Expert explains in further detail.

When you pass away or move into a permanent care facility, your home is sold and this is used to pay back the loan. You will pay interest on the amount you borrow, and this is often added to the loan amount and deducted from the sale of your home. You will often have the choice between taking the money in one lump sum or taking it in installments.

After you have taken out your equity release mortgage you will still be able to live in your home rent free. You will still be responsible for the maintenance of the house.

When choosing an equity release mortgage, it’s possible to ring fence a portion of the value of your home to save as an inheritance for your family. It’s also possible to protect yourself from negative equity by taking an equity release mortgage from a lender with a “no negative equity” guarantee. This will ensure that your family will not have to pay back more than you borrow.

How do self build mortgages work?

If you want to build your dream home instead of modifying an existing home, you may need a self build mortgage. Not everyone has access to a large pot of money to pay for building works. Instead, you can apply for a self build mortgage to cover the costs.

Unlike a residential mortgage which is paid in one lump sum, a self build mortgage is often released in stages. The first will allow you to purchase the land and subsequent payments will be staggered to allow you to pay for building work at key milestones. This helps to limit the risk to the lender, as things could go wrong at any stage in the process. You will typically get a payment to purchase the land, then another when the foundations have been laid, another when the roof is added and then further payments when the house is sealed and then completed.

With a self build mortgage, you will not only have to demonstrate why the home is affordable, you will also need to show your plans for building the new home. This will include a full breakdown of costs and how you plan to manage the build. Securing planning permission in the early stages is vital as this can quickly derail a project.

In general, a self build mortgage will have higher interest payments than a residential mortgage. You may also be asked to provide a much larger deposit which could be up to 50% of the total cost. But it’s important to think about the value of the home you will own at the end. You will often end up with a home that is worth a lot more than it cost to build it.

When you factor in the higher deposit and the fact that you will have to borrow a lot less than if you purchased an existing property, your mortgage repayments could be a lot less. Once the property is built, some lenders will allow you to remortgage on the new value of the property.

How do mortgages work in Scotland?

Mortgages in Scotland operate in a similar way to the rest of the UK. But with Scotland having its own legal system, there are a few differences that you will need to know about. First of all, there are fewer lenders operating in Scotland and many of them will have postcode restrictions, so it can limit your choice of lender.

Before making an offer on a property in Scotland, you will need to have something known as a mortgage in principle and your funding in place. This can make things more difficult if you are also selling a property. But the positive is that this means there are rarely breaks in the chain, which gives buyers and sellers some reassurance. Once a bid has been accepted, it is legally binding and the fine print can be worked out. This includes things like the move in date and which items are to be included in the property.

The actual mortgage application is very similar to the rest of the UK. You will be required to provide a deposit, usually between 5-25%. You will also have to pass eligibility checks, including checks on your income and outgoings, and your credit score. The only part that differs is that you will have to have a mortgage agreement in place before you can put in an offer. Without the mortgage in place, it is unlikely that your offer will be taken seriously.

How do business mortgages work?

Business mortgages are sometimes known as commercial mortgages. This is another type of business lending that can help companies and organisations to grow. They are typically used to secure property, purchase land for development, or to expand a buy-to-let portfolio. Business mortgages under £25,000 may be unsecured, but anything above this will need to be secured against another asset such as a residential property.

Business mortgages may last from three to 40 years in length, so they can be a significant undertaking. Unlike a residential mortgage, you will not be able to secure a business mortgage with a deposit lower than 20%. In general, you will need between 20-40% of the property value as a deposit.

Since business mortgages are considered to be higher risk than other mortgages, they may have higher interest rates than a residential mortgage. But these rates will often be better than a normal business loan, so it can be a cost-effective way to access money for expansion and growth. It’s also worth noting that the tax payable on your business mortgage will be tax deductible. And finally, business mortgages can be a good way to protect your business from future rent increases.

20 questions. How do mortgages work?

How do self cert mortgages work?

Self cert mortgages are also referred to as self certification mortgages, or self employed mortgages. This type of mortgage allowed the self employed to “self certify” their income on a mortgage application without providing any evidence. This type of mortgage was banned in 2014 after the Financial Conduct Authority reviewed the way self cert mortgages were used.

The self cert mortgage was also known as a “liars loan” as so many people used this loophole to access bigger mortgages. With so many people inflating their income to borrow more money, it was inevitable that this would soon become problematic for the mortgage industry as a whole. This is why self cert mortgages are no longer available.

This means that the self employed will now have to apply for their mortgage in the same way as everyone else. Instead of self certifying their income, the self employed have to provide between 1 and 3 years of accounts. Lenders will consider you to be self employed if you own more than 25% of a business and if it is your main source of income. This includes sole traders, contractors and company directors.

If you only have accounts for one year, it can be difficult for lenders to get a full picture of your earnings. The amount of time you have been self employed can impact the lending products available to you and which lenders are willing to work with you. It can be helpful to work with a whole market broker in order to find the best deals available to you.

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Niche Mortgage Info is a guidance website and introducer and is not regulated by the FCA. All of the advisers we partner with work only for firms who are authorised and regulated by the FCA and specialise in a number of different fields. They will offer any advice specific to you and your needs. The information on the site is not tailored advice to each individual reader, and as such does not constitute financial advice.

By making an enquiry you accept that your information will be passed to one of the specialists.

Niche Mortgage Info is a guidance website and introducer and is not regulated by the FCA. All of the advisers we partner with work only for firms who are authorised and regulated by the FCA and specialise in a number of different fields. They will offer any advice specific to you and your needs. The information on the site is not tailored advice to each individual reader, and as such does not constitute financial advice.

By making an enquiry you accept that your information will be passed to one of the specialists.